The Rolls-Royce (LSE:RR) share price has roughly tripled since the start of the year. While a repeat performance in 2024 seems unlikely, could the stock again be one of the FTSE 100’s top performers?
As I see it, the company has clearly benefitted from some one-off tailwinds in 2023 that aren’t likely to be repeated. But there’s plenty to like about the stock at the moment – and the market knows it.
A 2023 turnaround
A lot has gone right in 2023 for Rolls-Royce. The business has managed some impressive achievements in working towards undoing the damage done by the pandemic.
The most obvious part of this is the uplift in its servicing revenue as the number of flying hours for wide-body aircraft has returned to near pre-pandemic levels. This has boosted both margins and profits.
As a result, Rolls-Royce had its credit rating upgraded by Fitch earlier this month. A stronger credit rating should put the company in a better position when it comes to servicing its high debt load.
The firm has also been making other moves to improve its balance sheet. This has included cutting costs by reducing staff numbers and selling non-core operating divisions, such as its off-highway engines business.
All of this has led to a significant uplift in sentiment around the stock. Barclays, JP Morgan and Morgan Stanley have all upgraded their ratings on the stock recently, causing the Rolls-Royce share price to rise.
What’s next?
This is all positive stuff, but the question for investors now is what the next few years will look like for the business. The recovery in air travel demand looks like it might be complete, so what’s next?
It’s worth noting that the surge in the Rolls-Royce share price this year has pushed it close to the price targets analysts have set for 2024. That implies there might not be much room to run in the short term.
The highest price target I can see for 2024 is £4.31, implying an upside of around 49% from the current price. The average, though, is much closer to today’s level at £3.07.
In other words, analysts are generally positive on Rolls-Royce shares for next year, but the view is clearly that the pace of improvements is set to slow from here. That’s not a big surprise.
The post-pandemic recovery has now all but worn off, but the firm’s focus on improving returns in its core operations look like the right ones to me. So I think investors should feel positive for 2024.
Is it still a bargain?
At the start of the year, Rolls-Royce had a market cap of around £8.7bn. For a company with credible ambitious of achieving £3.1bn in annual free cash flow by 2027, that’s a clear bargain.
With the share price having roughly tripled, things are less clear. Even at today’s levels though, there’s still a 12% free cash yield if the company can hit its targets in the medium term.
The higher price makes the stock less of a bargain and more of a risk. But I wouldn’t bet against it having another positive year in 2024 – especially if the Bank of England cuts interest rates.
